Evolution of the deduction for loss of leisure activities in 2021


Pedants oppose the reference to Article 183 of the Code – Activities not engaged in for profit – as a “loss of hobby rule”, because, strictly speaking, it is not only hobby. Besides being used against people who want deductions for things they feel like doing, Section 183 has been a weapon of the IRS in the war on tax shelters.

Well, pedants scored a point in Section 183’s meager number of opinions in 2021. Nonetheless, I will continue to call the section the “lost hobby rule”. And here we have the hobby loss developments for the year.

A new audit guide

IRS issued Publication 5558 Uncommitted for Profit Activities Audit Technical Guide Section 183 of the Internal Revenue Code on September 7, 2021. This is a must read for anyone helping to plan a possible hobby loss audit or, of course, is facing one. The last review was in June 2009. I’m not sure if the new audit guide is a sign of renewed IRS interest in the matter or just a matter of getting it over with. Emphasis is placed on the importance of the stakes in 183 cases.

IRC 183 adjustments are permanent adjustments and should generally be treated as the main position unless the alternative issue converts loss into profit. IRC 469 Passive Loss of Activity Rules, IRC 465 Risk Limitations, and IRC 1366 and IRC 704 Basic Limitations are schedule adjustments and should be treated as alternate positions when the IRC 183 problem is also present.

The guide, as in the past, places great emphasis on the nine factors described in Regulation 1.183-2. I know you have them memorized, but you have to take other readers into account. Here they are:

(1) Way in which the taxpayer carries out the activity. (2) The expertise of the taxpayer or his advisers (3) The time and effort devoted by the taxpayer to the exercise of the activity (4) The expectation that the assets used in the activity may become value (5) The success of the taxpayer in carrying out other similar or dissimilar activities (6) The history of the taxpayer’s income or losses in relation to the activity (7) The amount of occasional profits, if any, that are carried out. (8) The financial situation of the taxpayer. (9) Elements of personal pleasure or leisure

Key points of the new audit guide

The guide explains to officers why their cases are being pushed back by appeals. Oddly enough, they seem to imply that this is a bad thing. The guide encourages agents to speak directly to taxpayers rather than dealing with representatives who do not have all the answers. So if you are a representative, make sure you have all the answers.

Much attention is paid to the presumption in section 183 (d). The presumption comes into play if there is profit three out of five or two out of seven years for horses. If anyone knows one thing about the lost hobby rules, it’s probably some kind of twisted version of the presumption. If you study the case law, you will find that it is of little practical importance. There is a very important comment about the presumption in the guide.

Examiners cannot use IRC 183 (d) as a ground for denying losses under IRC 183, even when the taxpayer does not meet the presumption.

It is a presumption in favor of taxpayers and cannot be used against them.

The other important point of the guide is that section 183 and related regulations are virtually unchanged from the early 1970s. Consequently, all of the nearly fifty years of jurisprudence remains relevant. Oddly enough, the guide doesn’t have much on case law. So here is your chance to be ahead of the revenue officers. For a roundup of the past decade, you might want to check out my An Honest Goal Trumps Realistic Expectations – Why Tax Professionals Should Be More Aggressive About Lost Hobby.

The latest case law

Unless I missed something, there have only been three 183 substantive opinions this year. There were two other reviews that mention 183, we’ll cover this last one first.

Carl Gregory TCM 2021-115 is a boat rental case – a classic 183 activity. Judge Courtney Jones ruling on a motion for interim relief argues that the deductions authorized by 183 (that is to say in the measurement of income from the activity) are subject to the 2% floor. There, no surprise. Lew Taishoff gave Vivian Hoard, Esq. a “good try” for having argued.

Sang J. Park 136 TC 569 tells the story of a South Korean executive who loves to gamble when he visits the United States. The opinion focuses on the Korean-American tax treaty. The notice alludes to 183 noting that factors are used to determine whether someone is playing as a trade or business and the petitioner did not respond to them.

Any hat without cattle

Stephen Whaltey TCM 2021-11 is summarized in the Tax Notes title of the opinion text – The cattle-less banker’s breeding farm was neither a trade nor a business. Mr. Whatley’s family had farmed and ranched in Lee County, Alabama for eleven generations. I think they should have started before it was Lee County, which was formed in 1866. Mr. Whatley had some farming experience in his youth, but found a career in banking more enjoyable. He was the founder, chairman, chairman, CEO and largest individual shareholder of the Southern States Bank.

Upon returning from his partnership, his Sheepdog Farm LLC describes itself as a farm and its primary product as cattle. There was also a lot of wood on the ground. Justice Holmes noted:

A livestock farm without livestock and a forest farm that is not yet harvesting timber is very likely to produce a bumper crop of losses.

Nonetheless, Justice Holmes performed the full nine-factor exercise. The score was 8-0-1. Judge Holmes gave him a break on the fourth factor.

Sheepdog Farms is first and foremost a cattle farm. Whatley’s old business had nothing to do with cattle. And growing wood is different from harvesting and felling. But we don’t want to deny some recognition of these entrepreneurial skills. We will call this factor neutral.

Overall, there is nothing very informative here. Lew Taishoff covered the decision with Forget the hat – No cattle.

Roping as a team

Of course, there had to be a horse case. Joseph Gallegos TCM 2021-25 taught me a new sport – team lassoing. Judge Holmes spices the decision up with puns. Describing Mr. Gallegos’ success in marketing insurance, he writes:

The affair is a galloping success. Gallegos was found to be exceptionally good at spotting promising people, and once he enrolled them in a training program and then unleashed them on the market, he could share the commissions they earned.

As Socrates said, a Youtube video is worth ten thousand words, so check it out to get a feel for the sport.

The video is not connected to the box. It’s just a background. Either way, Judge Holmes gave the IRS another 8-0-1 victory. The judge called the third factor, time and effort, neutral.

Even so, we believe that the time he devoted to the team roping, while not insignificant, could be done around a normal work schedule and is in line with his enjoyment for the horses.

I ended up not covering this case after speaking to Mr Gallegos who told me that Judge Holmes was wrong on the facts about the sport. Since I embarrassed myself to completely ignore Olympic dressage competition, I avoid delving into the sporting details of my stories. So that’s enough on this one.

And for the pedant

Preston Olsen TCM 2021-41 is the now rare example of the IRS attacking a tax shelter with Section 183. Judge Lauber notes that more than 200 cases of investors in the same scheme were pending the outcome of this case. Mr. Olsen was involved in a solar energy project. The genius behind it all was Neldon Johnson of International Automated Systems Inc.

The idea was to install “Fresnel lenses” on metal towers. The lenses would concentrate the sunlight which somehow produced energy. It is neither here nor there as there does not seem to have been much or no energy produced. Instead, investors would buy lenses that they would lease. It didn’t end well for Mr Johnson, as you can read in this press release from the DOJ – Federal Court orders Tax Regime Promoters To Spend $ 50 Million In Gains From Fraudulent Solar Energy Tax Scheme.

There are still all the little people to consider that I guess Mr. Olsen represents in some way. In the final order, Justice Lauber confirms a deficit of $ 108,791 for the years 2010 to 2014. Justice Lauber took a more holistic approach and did not consider the factors, although he mentioned some of them.

Basically the lenses were never used as part of a feeding system so there was no trade or business. Even if there had been losses and the credits would have been suspended under the rules of passive loss of activity of article 469 of the Code.

For what it’s worth, the Olsens have appealed to the tenth home circuit. The last element of the file is that they had until December 27, 2021 to file their brief.


Section 183 is one of the few areas where I think tax advisers are overly cautious. The law clearly states that a realistic expectation of profit is not required to incur a loss. What is needed is an honest goal. Hence Reilly’s eighteenth law on tax planning – Honest goal trumps realistic expectations. You demonstrate an honest purpose by behaving in a professional manner.

For an extended version of this argument, you can trade in an hour of your lifespan to listen to me buzz about it here.


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